Australia | Apr 19 2017
Coal industry dynamics have become more complex for Whitehaven Coal, as it benefits in the near term from the reduced supply in Queensland resulting from Cyclone Debbie.
-Production guidance reiterated, suggesting strong June quarter is needed
-Discount increasing as semi-soft sales are ramping up at Maules Creek
-Price spike in coking coal may be relatively short-lived
By Eva Brocklehurst
Semi-soft coking (metallurgical) coal prices are benefiting from the impact of Cyclone Debbie on Queensland production, creating upside to cash flow for Whitehaven Coal ((WHC)), which has mines at Maules Creek and Narrabri in NSW that are unaffected by the weather event.
Yet the company's March quarter production performance was weaker than brokers forecast because the Narrabri longwall move occurred earlier than expected. Output at Narrabri fell -29% in the March quarter as the longwall move constrained mining.
In contrast, Maules Creek hit its 10.5mtpa operating rate target. The company has reiterated FY17 production guidance for 21-22m tonnes of saleable coal, which suggests to brokers a strong June quarter is needed. The company reported prices of US$119/t for metallurgical coal and US$83/t for thermal coal and realised a 2% overall premium on thermal coal sales with Maules Creek at a 9% premium.
Ord Minnett finds it hard to predict the next quarter's achieved prices, as semi-soft coking prices are benefiting from the impact of Cyclone Debbie on Queensland production. The broker suspects further upside for metallurgical coal markets is limited, following the recent spike, and any weakness could result in near-term pressure on Whitehaven's share price. Nevertheless, the valuation metrics appear attractive enough to tolerate this scenario.
At the end of the March quarter discussions between producers and steel mills stalled as Cyclone Debbie hit the coast of Queensland. The effect of this disruption is still driving the industry while Japanese steel mills are short on inventory. Hence, the company suggests that the June quarter contract is unlikely to be settled before the end of April.
UBS forecasts realised metallurgical coal prices of around US$118/t based on a spot average of US$100/t and a June quarter settlement of US$135/t. The broker acknowledges a risk to the upside for its estimates, noting the company's ultimate aim is to have a majority of its metallurgical coal under contract but conversion from spot is slow because of the current backdrop.
The longwall change-over at Narrabri interrupted production by more than Ord Minnett expected, although the move to wider coal faces is almost complete. The stock continues to screen attractively across a range of metrics and the broker believes it is well placed to take advantage of buoyant coal markets.
Contract and spot price differentials continue to skew the realised price and Morgan Stanley envisages around $50m in cash flow upside for the June quarter. The broker observes the falling spot price for metallurgical coal has resulted in some customers re-scheduling volumes, suggesting 250-300,000 tonnes of sales at the March quarter benchmark in the subsequent quarter. As spot prices are on the rise again, following the disruption from Cyclone Debbie, this creates upside to cash flow.
Morgan Stanley is watching for sufficient upside to review the stock, still expecting increasing production, improved product mix and the potential for better price realisation, along with a reduction in net debt going forward.
Citi expects volumes to catch up in the June quarter as well as the carry-over of semi-soft tonnage, coupled with the normalisation of production at Narrabri. The main risk to the broker's outlook is a quicker recovery in Queensland coal supply and higher Chinese/Indonesian coal output.
With recent price volatility from Cyclone Debbie, Deutsche Bank increases June quarter realised pricing estimates to US$130/t and upgrades FY17 earnings estimates by 6%. The broker observes the company is generating strong free cash flow and rapidly de-gearing.
Macquarie notes, while the company has been ramping up volumes of semi-soft sales as Maules Creek production increases, the discount has been steadily increasing as well. This has grown to 30%, at what the broker believes is a peak in semi-soft prices, from 20% in the prior quarter.
The stock has been the beneficiary of a strong rally in coal prices as well as its operating successes, but larger discounts appear to be needed to increase semi-soft sales to the market.
While Macquarie acknowledges the business will re-gain some revenue from reducing inventory in the June quarter this is not expected to be achieved along with significantly higher prices. Based on slightly lower sales volumes and the miss on pricing in the quarter, the broker believes the build-up of cash will be lower than what was previously expected. Macquarie downgrades to Underperform from Neutral.
Morgans, too, is cautious, believing the latest price spike in coal will be relatively short-lived as seaborne supply recovers and there is an easing of 2016 Chinese domestic constraints. Ex Bowen Basin producers are beneficiaries of the disruptions from Cyclone Debbie but the broker expects physical coal markets to steadily normalise through the balance of the year.
The broker suspects the size, liquidity and high cash margins of the stock will drive interest from investors that are looking for default resources exposure in a market that lacks a wide range of quality mid cap stocks. Nevertheless, as the stock is trading in line with valuation, the broker retains a Hold rating.
The Vickery environmental impact statement will be lodged in the June quarter, allowing discussions with prospective partners to begin. The mine is several years away from the commencement of production and Morgan Stanley only attributes $150m in value at this point in time. If a stake is sold down at a price that implies a higher value the broker acknowledges it will need to consider revising its numbers.
FNArena's database shows three Buy recommendations, three Hold and one Sell (Macquarie). The consensus target is $3.21, suggesting 9.9% upside to the last share price.
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